BILL ANALYSIS AJR 12 Page 1 ASSEMBLY THIRD READING AJR 12 (Block) As Amended June 3, 2009 Majority vote REVENUE & TAXATION 6-3 ----------------------------------------------------------------- |Ayes:|Charles Calderon, Beall, | | | | |Coto, Ma, Portantino, | | | | |Saldana | | | | | | | | |-----+--------------------------+-----+--------------------------| |Nays:|DeVore, Harkey, Hagman | | | | | | | | ----------------------------------------------------------------- SUMMARY : Requests that the United States (U.S.) President and Congress enact legislation that closes the corporate federal tax loopholes relating to tax haven countries. Specifically, this bill : 1)States all of the following legislative findings and declarations: a) In bad economic times, states are forced to cut essential services or raise taxes in order to balance their budgets; and, recapturing lost revenues otherwise due to a state is one mechanism by which government can reduce painful cuts without raising new taxes. b) A U.S. corporation is taxed on all of its income, regardless of source, and is allowed a credit for any taxes paid to a foreign country. A U.S. corporation can operate globally in foreign countries directly through a branch or indirectly through its ownership in a foreign subsidiary. c) The Organization for Economic Cooperation and Development prepared reports identifying tax haven countries and financial privacy jurisdictions. d) The U.S. Department of Treasury has found that some U.S. corporations have aggressively moved income to offshore jurisdictions to avoid U.S. taxes and the U.S. Senate Permanent Subcommittee on Investigations released findings AJR 12 Page 2 regarding the growth of multinational corporations' use of tax haven countries to shelter income. e) President Obama has voiced his support for efforts to combat offshore tax evasion and the U.S. Commissioner of the Internal Revenue Service (IRS) stated that it is a top priority for the IRS. f) U.S. Senator Carl Levin introduced the Stop Tax Haven Abuse Act on March 2, 2009, to target offshore tax abuses that deny the U.S. Treasury an estimated $100 billion in revenue each year. g) Some states have enacted legislation to include the income and apportionment factors of affiliated corporations doing business in, or having income derived from, or attributed to, a tax haven country. h) California permits corporations that conduct business in this state to elect to calculate their state corporate tax liability based on income only from sources within the U.S. i) As identified by federal officials, corporations are known to redirect income to foreign subsidiaries located in offshore tax haven countries to hide those corporations' true income and to avoid paying their fair share of state tax. The Franchise Tax Board (FTB) estimates that California incurs an annual revenue loss of approximately $130 million due to corporations' sheltering income in tax haven countries. 2)Respectfully requests the U.S. President and Congress to enact legislation that would close the corporate federal tax loopholes currently allowing the sheltering of income in offshore tax haven countries and would, instead, promote transparency, cooperation, and tax compliance. 3)Requires the Chief Clerk of the Assembly to transmit copies of this resolution to the President and the Vice President of the U. S., to the Speaker of the House of Representatives, to the Majority Leader of the Senate, and to each Senator and Representative from California in the U.S. Congress. AJR 12 Page 3 FISCAL EFFECT : Unknown but probably none. COMMENTS : The author states that "California corporations are stashing millions of dollars in overseas tax haven countries, and are avoiding paying their fair share of taxes to the state through code loopholes. President Obama and the U.S. Congress have hinted they would like to close these loopholes at the federal level, in which case California would benefit as well. I applaud their efforts and hope the California Legislature can join me by passing AJR 12, which will encourage the federal government to act to solve the tax haven abuse loopholes." What is the problem with incorporating a subsidiary in a tax haven country? Some corporations and individuals use tax havens to avoid payment of U.S. taxes. Generally, a tax haven is a foreign jurisdiction that maintains corporate, bank, and tax secrecy laws and industry practices that make it very difficult for other countries to find out whether their citizens are using the tax haven to avoid paying their taxes. (Statement of Senator Carl Levin on Introducing The Stop Tax Haven Abuse Act, Tax Analyst, December 2009, p. 4). Data released by the Commerce Department indicates that, as of 2001, almost half of all foreign profits of U.S. corporations were in tax havens. Further, a study released by Tax Notes, September 2004, found that American companies were able to shift $149 billion of profits to 18 tax haven countries in 2002, up 68% from $88 billion in 1999. In January 2009, a report issued by the Government Accounting Office (GAO) shows that out of the 100 largest U.S. publicly traded corporations, 83 have subsidiaries in tax havens. For example, Morgan Stanley has 273, Citigroup has 427, and Oracle has 77 tax haven subsidiaries. U.S. Senator Levin, in his statement, gives a simplified example of how U.S. corporations may transfer taxable income from the U.S. to tax havens to escape taxation. He states that, "Suppose a profitable U.S. corporation establishes a shell corporation in a tax haven. The shell corporation has no office or employees, just a mailbox address. The U.S. parent transfers a valuable patent to the shell corporation? [and then] begin to pay a hefty fee to the shell corporation for use of the patent, reducing its U.S. income through deducting the patent fees and thus shifting taxable income out of the United States to the shell corporation. The shell corporation declares a portion of the fees as profit, but pays no U.S. tax since it is a tax haven AJR 12 Page 4 resident." In addition, the shell corporation may lend its funds to the U.S. parent that, in turn, will pay interest on the loan to the shell corporation, shifting more taxable income out of the U.S. to the tax haven. Often, those subsidiaries of U.S. companies are shell corporations that are engaged in no or very little business activity. (Id, at p. 6) Under existing California law, income and apportionment factors of those subsidiaries located in tax haven countries are not included in the water's-edge return of the parent company, unless the subsidiaries are certain affiliated entities such as, for example, an export trade corporation, a domestic international sales corporation, a foreign sales corporation, or a controlled-foreign corporation with Subpart F income. Consequently, companies that manage to shift some of its income to their subsidiaries in tax haven countries will pay less tax to California. Proposed federal legislation: Section 103 of the Stop Tax Haven Abuse Act would deny tax benefits for foreign corporations managed and controlled in the United States. It focuses on the situation where a corporation is incorporated in a tax haven as a mere shell operation with little or no physical presence or employees in the jurisdiction. The impetus for this legislation came from a hearing held by the U.S. Senate Finance Committee in July 2008. The Committee considered the findings made by GAO with regard to the infamous Ugland House, a five-story building that is located in the Cayman Islands and is the official address for over 18,800 registered companies. GAO determined that about half of the alleged Ugland House tenants have a billing address in the United States and were not actual occupants of the building. In fact, GAO found that none of the nearly 19,000 companies registered at the Ugland House was an actual occupant. The only occupant of that building was a Cayman law firm that established and registered those companies. Section 103 of the Stop Tax Haven Abuse Act states that, if a corporation is publicly traded or has aggregate gross assets of $50 million or more, and its management and control occurs primarily within the United States, then that corporation will be treated as a U.S. domestic corporation for income tax purposes. Section 103 provides an exception for foreign corporation with U.S. parents but makes clear that mere AJR 12 Page 5 existence of a U.S. parent corporation is not sufficient to shield a foreign corporation from being treated as a domestic corporation. According to U.S. Senator Levin, the proposed federal legislation "would put an end to the unfair situation where some U.S.-based companies pay their fair share of taxes, while others who set up a shell corporation in a tax haven are able to defer or escape taxation, despite the fact that their foreign status is nothing more than a paper fiction." (Statement of Senator Carl Levin on Introducing The Stop Tax Haven Abuse Act, Tax Analyst, December 2009, p. 13). How would California benefit from the proposed federal legislation? If the Stop Tax Haven Abuse Act is enacted into law, it will change taxpayers' behavior and, presumably, put an end to financial gimmicks used by certain corporate taxpayers to avoid or minimize their U.S. taxes. Most likely, California would indirectly benefit from that change in the taxpayers' behavior. It is unclear, however, and depends on the specific federal act, whether California would need to conform to the new federal law to see an actual increase in state tax collection. Similar legislation: AB 1178 (Block), introduced in this legislative session, would require multinational corporations that elect to file tax returns based only on income earned inside the U.S., known as the water's-edge method, to include the entire income and apportionment factors of any related corporation doing business in or having income derived from or attributable to a tax haven. AB 34 (Ruskin), introduced in the 2005-06 legislative session, was nearly identical to AB 1178 and would have required taxpayers filing on a water's-edge basis to include the income and apportionment factors of affiliated corporations doing business in, or having income derived from or attributable to, a tax haven. AB 34 failed to pass out of the Assembly. AB 441 (Chu), introduced in the 2005-06 legislative session, would have required a corporation that makes a water's-edge election to include the income and apportionment factors of certain foreign affiliates. AB 441 failed to pass out of the Assembly. SB 663 (Migden), Chapter 22, Statutes of 2006, clarified specific provisions of the franchise tax law relating to AJR 12 Page 6 water's-edge taxpayer and reformed the water's-edge procedure by replacing existing rules creating a contract between the taxpayer and FTB with election procedures. Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098 FN: 0001445